Measuring a Family Business’ ‘Goodwill’ in California Divorce Cases – In re Marriage of Kaur and Dhillon

When a couple decides to divorce, one of the many issues that they often grapple with is how to divide community property. California law provides that any and all assets acquired due to the efforts of either spouse during the course of the marriage are to be split evenly between them upon divorce. Sometimes this means awarding an asset to one spouse and requiring him or her to make an equalizing payment to compensate the other spouse for their interest in the property. First, of course, you have to know how much the property is worth. Assets such as real property or financial accounts are generally easy to value, whereas a business can be very complex. A recent case out of the Sixth District Court of Appeals is a good example of how courts may determine the value of a family business, a figure that often includes “goodwill” built up by the business over time.

Husband and Wife moved to California from India at some point after they married in 1976. Husband started his own trucking company in 1993, and Wife worked seasonally as a produce packager to supplement the family’s income. They bought a home in Watsonville, with Husband using income from the business to pay the mortgage and Wife using her wages to cover certain household expenses. They separated in February 2009 but continued to live in the home. Husband continued making the mortgage payments through May 2012, when Husband moved out of the home after Wife filed for divorce. They reached an agreement wherein Wife was responsible for the mortgage payments and Husband paid her $465 per month in temporary spousal support.

Following a divorce trial, a court awarded Husband the full trucking business and an equalizing payment to Wife. The trial court found the business had an overall value of $40,000, including $15,000 in actual value and $25,000 in goodwill. The goodwill aspect was based largely on Husband’s business relationship with his cousin, which the trial court said allowed him to gain a steady revenue stream without incurring marketing expenses.

Affirming the decision on appeal, the Sixth District found that the trial court’s goodwill valuation was supported by substantial evidence. “No rigid rule applies for determining the value of goodwill,” the Court explained. “Rather, it may be measured by any legitimate method of evaluation that measures its present value by taking into account some past result, so long as the evidence legitimately establishes value.” Here, the Court rejected Husband’s claim that the business had no goodwill value because he’s not a trucking industry professional. Instead, the Court said that the entity met the definition of a business to which goodwill may attach. The court found specifically that the business was a commercial enterprise because Husband had deducted business expenses for tax purposes over the years. It also said that the business had at least one asset, a tractor trailer.

Business valuation is often a hotly contested matter in divorces but it need not be so. There are generally three approaches to valuing a business: the asset approach, the market approach, and the income approach.

The asset approach uses a fairly simple formula: assets minus liabilities = value. Assets include both tangible and intangible assets. Tangible assets include physical objects such as infrastructure and inventory. Intangible assets are non-physical objects such as patents, accounts receivables. While this approach seems straightforward, it can actually be rather difficult. Some items, like company vehicles, may be easy to value by using a value book. Other items, such as the computers in the office, or the tables in a restaurant would be more difficult to value. Inventory is typically valued at cost, but this can vary based on the age and type of inventory. Further, there may not be a value book that covers the type of inventory at issue. This approach also doesn’t take into consideration any unrecorded assets and liabilities which could create further issues. Because of these complications, this approach tends to work best for small businesses.

The market approach compares the business to similar businesses that have been sold. This approach is similar to how appraisers will look at “comps” in a neighborhood when determining the value of the house. This approach can prove difficult, however, if there are no similar businesses that have recently been sold that can provide an accurate comp.

The income approach uses historical information and particular formulas to predict expected cash flow and profits in calculating the value of the business. The formulas used consider future benefits as well as the rate of risk or return. This is the most common approached used to determine a value of a business.

In litigated cases where spouses engage in a “battle of the experts”, they can expect their legal fees and costs to increase dramatically. In addition to the cost of the expert, legal fees will increase since the attorney will have to spend time learning and understanding the expert’s analysis.

Spouses who have agreed to try to resolve the issues through mediation or Collaboration, typically retain an expert jointly and both participate in providing the information to the expert so that ultimately both are likely to agree on the range of values provided for the business.

Business valuation is just one of the many issues that come up in California divorce cases. These issues – and much of the stress that often accompanies divorce cases – can be minimized through alternatives to litigation, such as collaborative divorce and mediation. With offices throughout the San Francisco Bay Area, California divorce lawyer Lorna Jaynes provides innovative legal tools to resolve many family law disputes without the bitterness and acrimony engendered by the adversarial process.